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Abstract
The authors argue that cointegration analysis is an intriguing development for analyzing marketing interactions in dynamic environments.
Methodologically, the use of cointegration analysis requires statistical tests to determine whether this technique is appropriate for the system
under investigation and, if it is appropriate, other statistical tests are needed to interpret the results. The authors collate a set of statistical tests
and techniques to advance a comprehensive methodological framework that utilizes cointegration analysis to examine marketing interactions
in dynamic environments. The framework is useful for analyzing marketing parameter functions with time-varying coefficients to investigate
the relationship between market performance (e.g., sales, market share), marketing effort (e.g., advertising, sales promotion), and
environmental conditions (e.g., market growth, inflation). The authors illustrate the utility of the framework for the famous case of Lydia
Pinkham Medicine Company (LPMC). D 2000 Elsevier Science Inc. All rights reserved.
Keywords: Cointegration analysis; Marketing interactions; Dynamic environments; Lydia Pinkham Medicine Company
1. Introduction Since the path breaking paper by Granger (1981) and the
subsequent conceptual and methodological developments
At the nucleus of marketing research and theorizing, lie by Engle and Granger (1987), cointegration analysis has
marketing interactions. Marketing interaction mechanisms become an integral part of non-stationary time series ana-
determine the relationship between marketing performance lysis. Murray (1994) provided an intuitive explanation of
(e.g., sales, market share), marketing effort (e.g., advertis- cointegration. Murray (1994) uses the analogy of a drunkard
ing, personal selling), and environmental conditions (e.g., walking her dog to explain the notion of cointegration. The
growth rate, competitive activities). Typically, researchers drunk and her dog wander aimlessly, but make sure that they
use market response models to investigate marketing inter- have an eye on each other and do not separate by more than
actions in order to examine the behavior of markets and a certain distance. Thus, even though both of them do not
predict the impact of marketing actions (Hanssens et al., know where they are going, they do know that they are
1990; Leone, 1995). Given the importance of marketing going together. In a way, the drunk and her dog are
interactions, scholars have proposed various methodological cointegrated. Formally speaking, two or more non-station-
frameworks to model these interactions (cf., Wildt and ary variables, which are integrated of the same order, are
Winer, 1983; Gatignon and Hanssens, 1987). Recent meth- cointegrated if there exists a linear combination of these
odological advances in econometrics concerning cointegra- variables that is stationary. Specifically, cointegration ana-
tion analysis provide a new technique to analyze these lysis involves time series data and multi-equation time series
interactions. In this paper, we utilize recent advances in models, allowing for systematic and random parameter
econometrics concerning cointegration analysis to illustrate variation, with two or more variables.
a framework for analyzing marketing interactions. Marketing researchers have used multi-equation time
series models to investigate various phenomena. For exam-
* Corresponding author. Tel.: +1-509-335-5848; fax: +1-509-335- ple, such models have been used to study the interaction
3865. between the structure of marketing function (brand vs.
E-mail address: grewal@wsunix.wsu.edu (R. Grewal). category management) and competition (cf., Zenor, 1994;
0148-2963/01/$ ± see front matter D 2000 Elsevier Science Inc. All rights reserved.
PII: S 0 1 4 8 - 2 9 6 3 ( 9 9 ) 0 0 0 5 4 - 5
128 R. Grewal et al. / Journal of Business Research 51 (2001) 127±144
Curry et al., 1995); advertising and price sensitivity (cf., tion analysis requires that all data series under investigation
Eskin and Baron, 1977; Krishnamurthi and Raj, 1985); to be integrated of the same order, which implies that one
advertising, temperature, price, and consumer expenditure has to perform statistical tests on the data series under
(Franses, 1991); advertising, price sensitivity, and competi- investigation to make sure that the system under investiga-
tive reaction (Gatignon, 1984); advertising and product tion is suitable for cointegration analysis. In addition,
quality (Kuehn, 1962); advertising and product availability drawing conclusions from the estimation results of coin-
(Kuehn, 1962; Parsons, 1974); advertising competition tegration analysis requires more statistical tests. The main
(Erickson, 1995); advertising expenditure and advertising objective of this article is to demonstrate a comprehensive
medium (Prasad and Ring, 1976); advertising and prior methodological framework for analyzing multi-equation
sales person contact (Swinyard and Ray, 1977); advertising time series data using cointegration analysis. Such a frame-
and personal selling (Carroll et al., 1985); competitive work is of considerable interest to both marketing scientists
behavior (Hanssens, 1980b); sales force effectiveness and and marketing managers, as better understanding of mar-
environmental hostility (Gatignon and Hanssens, 1987); keting interactions is of interest to both parties. Both are
integrated marketing communications (cf., Beard 1996; interested in marketing interactions because they want to
Hutton, 1996); persistence modeling (Dekimpe and Hans- know what drives marketing performance. Our framework
sens, 1995a,b); and consumer confidence (Kumar et al., provides both parties with tools and a systematic method to
1995) among others. study these interactions. Further, a comprehensive and
In most cases, conventional multi-equation time series consistent framework makes it easy to identify unifying
analysis involves the use of Vector Autoregressive (VAR) principles that aid in empirical generalization and advance-
models with two or more stationary variables (cf. Hamil- ment of marketing science (cf., Bass, 1993, 1995; Bass and
ton, 1994; Enders, 1995). Typically, one differences non- Wind, 1995). Finally, such a framework would be useful
stationary difference variables to make them stationary for pedagogic exposition.
and then uses them in a VAR model to investigate To achieve our objectives, we survey recent develop-
underlying data generation mechanisms (cf., Curry et al., ments in the econometrics and time series literature to
1995; Dekimpe and Hanssens, 1995b). Differencing non- collate a set of statistical tests and estimation techniques,
stationary variables results in loss of information (cf., which are useful in exploration of marketing interactions.1
Enders, 1995). Cointegration analysis provides a metho- Based on our literature review, we illustrate the usefulness
dology for analyzing non-stationary variables, without of cointegration analysis in marketing and provide the
making them stationary, thereby preventing loss of infor- rationale for expecting specific type of behavior from
mation due to differencing. various marketing variables. Furthermore, we demonstrate
Examples of marketing systems with non-stationary the proposed framework to model marketing interactions
variables, which are related to each other and, thus, would for the famous case of Lydia Pinkham Medicine Com-
benefit from cointegration analysis are plentiful. For in- pany (LPMC).
stance, in a typical diffusion of innovation setting, where a
new product is replacing an existing product, the sales of
these two products, promotion and advertising spending, 2. Methodological framework and conceptual
along with sales of competing products, are likely to move underpinnings
together and thereby be cointegrated. In addition, cointegra-
tion analysis is a useful tool to examine sales force effec- Marketing interactions, by their very definition, imply
tiveness (cf., Gatignon and Hanssens, 1987) and in that interactions among several marketing effort variables,
understanding the implications of various pricing decisions along with their interaction with environmental variables,
and strategies on marketing performance (cf., Curry, 1993). determine marketing performance. Further, when firms take
These explications for application of cointegration analysis decisions concerning marketing effort, they may take mar-
in marketing are by no means exhaustive and are meant as keting performance into consideration. In addition, environ-
mere illustrations of the usefulness of cointegration analysis ment interacts with both performance and effort to further
in investigating marketing interactions. complicate matters. For example, the time of the year and
Marketing researchers are just beginning to use coin- advertising expenditure in the previous month together
tegration analysis to study marketing interactions. Specifi- determine sales which in turn determines advertising ex-
cally, a couple of studies (Baghestani, 1991; Zanias, 1994) penditure this month which in turn influences sales. Multi-
examine the advertising ± sales relationship and Franses equation modeling helps in capturing this dynamic behavior
(1994) has studied the sales of new products. These studies
and our illustrations demonstrate the utility of cointegration 1
We choose the statistical tests that in our opinion are most
analysis; however, the intricate nature of theoretical re-
appropriate. We do not claim that these are the only or universally the
search on cointegration limits its use. Our primary objec- best statistical tests for the purpose. Our objective is to provide and
tive is to summarize theoretical cointegration literature to illustrate the steps of our framework and not to determine the goodness of
facilitate its use by marketing scholars. Utilizing cointegra- one test vis-a-vis another.
R. Grewal et al. / Journal of Business Research 51 (2001) 127±144 129
in the market place. In Appendix A, we present a typical Uncovering these aspects of the data generating mechan-
multi-equation model, which captures the dynamics of isms, provides information whether the variables being
marketing interactions. studied are suitable for cointegration analysis or not. Sub-
To capture marketing interactions in a cointegration sequently, in the next two tests, i.e., cointegration test and
framework, we propose a nine-step framework to investi- estimation techniques, we use the results from the first four
gate the complex system represented in the two equations steps to model the interactions between environment, effort,
we present in Appendix A (Fig. 1). In the first four steps of and performance variables. Finally, in the final three steps,
the framework, i.e., unit root test, structural break test, unit i.e., Granger causality, variance decomposition, and impulse
roots with structural tests, and reconciling the results from response functions (IRFs), we use the inputs from the
the two unit root tests, we are concerned with determining cointegration results to uncover interrelationships between
the data generation process of each individual variables. the variables under investigation. In the remainder of this
section, we enumerate on each of the nine steps in our structural breaks, like the exogenous oil price shock of
framework and provide reasons for expecting certain beha- 1973, most of the macroeconomic series are either sta-
vior by marketing performance variables, marketing effort tionary or trend-stationary. If a series is stationary or trend-
variables, and environmental variables. stationary, cointegration analysis is not an option. Clearly,
it is important to account for structural breaks when
2.1. Unit roots2 modeling economic time series to identify modifications
in the data generation process. As Perron (1989) demon-
Dekimpe and Hanssens (1995a) operationalized the strated, overlooking structural breaks might mislead con-
concept of stationary and evolving markets based on the clusions concerning the underlying data generation
unit root tests. The unit root tests examine each time series process, which may lead to model misspecification and
to determine whether the mean, variance, or autocorrela- wrong conclusions.
tion of the underlying data generation process for each of There are two major issues concerning structural breaks.
these variables increases or decreases over time. A time The first concerns the time when the break has its effect on
series whose mean or variance or autocorrelation either the underlying data generation process: immediately after
vary over time or are not finite might be non-stationary the event of interest or after a certain lag. Typically, either
and may have a unit root. Classical linear regression of the two cases is possible. If the event of interest is high-
models requires data series under investigation to be profile (e.g., oil shock of 1973), we might expect an
stationary and if this assumption is violated it leads to immediate change. For low-profile interventions, like the
the problem of spurious regression (Granger and Newbold, actions of competitors or reprimand by federal agencies, the
1974). Further, cointegration analysis requires all series structural change might be delayed, as the information
under investigation to be non-stationary. Hence, it is needs time to diffuse through the social system (Mahajan
important to identify, initially, the order of integration of et al., 1990).
the data generation process. The second issue concerns the nature of the break. One
One could hypothesize many marketing variables to be can expect the mean of a series to change, or the slope of
non-stationary based on their data generation process (De- the data series to change, or changes in both mean and
kimpe and Hanssens, 1995b). For example, the vast litera- slope. An example of change in mean would be high-
ture on diffusion of innovation suggests that the sales profile shocks, though this effect might be temporary.
figures for a successful new product will grow during its Interventions due to sales promotions or federal legisla-
initial years (cf., Mahajan et al., 1990). Further, one can tion's fall in this domain. Changes in slope might be a
expect price of some products to increase over time, perhaps result of federal regulations, competitive interventions, etc.,
due to inflation, and thereby be non-stationary. In addition, which need time to implement and diffuse through the
it is possible that price of some products decreases over time social system. For instance, let us say that a federal agency
due to experience curve effects (Bass, 1995), thereby issues a cease and desist order. The effect of this order
representing a non-stationary data generation process. could be gradual as information diffuses through the
concerned social system (Mahajan et al., 1990). Finally, a
2.2. Structural breaks successful new product introduction by the competitor can
instantaneously reduce a firm's sales (change in mean) and,
The structural breaks represent a point or an interval in in addition, after the instantaneous effect, the influence of
time, which denote modifications in the underlying data the new product may gradually erode more sales (change
generation process. The modifying agent is usually an in slope).
extraneous event. For example, structural breaks in sales The time of structural change and the nature of the
might be due to interventions of federal regulatory agencies, change are interesting in and of themselves. In addition,
as in the case of tobacco industry, where federal regulations these univariate tests shed light on modifications in the data
on how and where to sell tobacco products are plentiful (cf., generation process for the time period under investigation.
Rogers, 1994; Economist, 1996; France, 1996). Other ex-
amples of structural breaks include competitive new product 2.3. Unit roots after incorporating structural breaks
introductions and new generation of products (cf., Norton
and Bass, 1987, 1992; Mahajan et al., 1993). Perron (1989) found most macroeconomic data series to
While analyzing 14 macroeconomic time series, Perron be either stationary or trend-stationary after incorporating
(1989) provided a startling finding that after correcting for structural breaks. Traditional unit root tests (cf., Dickey
and Fuller, 1981; Phillips and Perron, 1988) do not
2
compensate for structural changes. Thus, it is possible
In the remainder of Section 3, we elaborate on the rationale for that these traditional tests find unit roots in stationary
expecting specific behavior form marketing variables. The statistical
aspects of these tests and estimation techniques are discussed in Section
process due to structural breaks. Hence, it becomes
4, where we illustrate the framework for the famous case of Lydia important to account for unit roots after incorporating
Pinkham Medicine. structural breaks.
R. Grewal et al. / Journal of Business Research 51 (2001) 127±144 131
2.4. Reconciling unit root tests before and after stationary. Various estimation procedures, such as Johan-
incorporating structural breaks sen's MLE, Box-Tiao, and OLS, are available to estimate
the rank of the cointegrating vector (which equals the
The main reason to perform unit root tests after incor- number of cointegrating vectors) and the cointegration
porating structural breaks is to overrule the possibility that a relationships. Typically, Johansen's MLE (we use this
structural break may be causing misperceptions concerning method in our illustration) performs well with reasonable
the stationarity of the variables under study. Further, there large sample sizes (cf., Johansen, 1988; Hargreaves 1992).
exists a possibility that the unit root tests before and after Once we have obtained the VAR and/or VECM parameter
incorporating structural breaks may not agree. If the results estimates, we use these estimates to uncover the interactions
agree then we establish robustness of the findings. If the among the variables in the system. Specifically, we use
results do not agree, Perron (1989) suggests that one should Granger causality, variance decomposition, and IRFs to
proceed with and estimate models with the results from both study the dynamic system.
unit root tests.
So far, we have laid down the steps to investigate the 2.7. Granger causality
underlying data generation process of each individual data
series and have not examined the interaction between these We expect marketing effort to determine marketing
data series. One can use the results from these steps to performance, in the words of time series literature, market-
formulate an appropriate model for further investigation. ing effort Granger causes marketing performance. Often the
Further, if we have two or more non-stationary time series, time paths of the two variables, marketing effort and
there is a possibility that these variables may be cointe- marketing performance, might show that the two variables
grated. In such a case, we must proceed with the coin- move together, e.g., both increase and decrease together. A
tegration tests, otherwise a VAR with stationary variables possible conclusion is that marketing effort is determining
is appropriate. marketing performance. However, one can also argue that
the firm is determining marketing effort based on marketing
2.5. Cointegration performance. After all, constant advertising to sales ratio
strategies are quite common (Erickson, 1991). How do we
In this step, we decide whether cointegration analysis is determine whether effort is determining performance, or
appropriate or not. If the variables under investigation are performance is determining effort, or both are determining
non-stationary and integrated of the same order, cointegra- each other? Granger causality can help determine this.
tion analysis is mandatory. It is important to identify a
cointegrating relationship between non-stationary variables 2.8. Variance decomposition
because such a relationship implies an equilibrium between
these variables and overlooking this equilibrium results in The decomposition of forecast error variance throws light
misspecifications in the error term (cf., Enders 1995). For on the effect size, i.e., how much of the forecast error
example, we expect marketing effort to influence marketing variance of the focal variable is being explained by the
performance, and for some products, we expect both types variables of interests. For example, it helps to answer
of variables to be non-stationary, e.g., in high-growth questions like how much of forecast error variance of sales
markets. Hence, we expect marketing effort and marketing is being explained by marketing effort and how much is
performance to be cointegrated. being explained by environmental variables.
We propose the use of standard VAR and Vector Error After giving a shock to a particular variable in a system,
Correction Models (VECM) to estimate the relationship we use IRF to trace the time paths of all variables in the
between the variables under investigation. If some variables system. For instance, if we give a 10% shock to a firm's
are non-stationary, but are not cointegrated, then one has to advertising (in other words, we increase/decrease the firm's
difference them in order to make them stationary. Subse- advertising expenditure by 10%), we use IRFs to answer
quently, we use these differenced transformed variables to questions such as: Does the shock to advertising have a
estimate a VAR. Further, if one has cointegrated variables, delayed effect on sales? How long does this effect last?
one can estimate either a VAR in levels (i.e., with variables What is the likely effect on the sales of competitor's
that have not been differenced), or VECM (cf., Toda and product? What is the likely reaction of the competitor?
Yamada, 1996). To sum, the last three steps of the nine-step framework
However, before estimating a VECM, we have to deter- provide insights into the interactions between the variables
mine the cointegrating relationship that we can use as an under investigation. They aid in understanding the influ-
independent variable in the VECM. This relationship is a ence of marketing effort and environment on marketing
linear combination of the cointegrating variable and is performance and also help to uncover any feedback from
132 R. Grewal et al. / Journal of Business Research 51 (2001) 127±144
performance to effort and/or environment. For the purpose tonic and tablet forms, was fairly stable over this time
of illustrating the framework, we examine the famous case period.3 Newspaper was the primary advertising medium
of LPMC. used by the company and the media allocation remained
fairly stable for the duration of the study.
The primary role of advertising in the marketing strategy
3. Research setting: the LPMC of LPMC, the lack of competitors, and the availability of
detailed data result in a rather unique natural experiment for
We choose the LPMC to illustrate our methodological studying the advertising ±sales relationship, with minimal
framework for two reasons. Besides easy access, we choose variation in other variables (such as price, advertising
this database because two recent articles (Baghestani, 1991; medium, etc.). The uniqueness of the LPMC experience
Zanias, 1994) have examined this database using cointegra- has led to an extensive literature analyzing the database.
tion analysis and we wanted to demonstrate that important Beginning with Palda (1964), who estimated the Koyck-
underlying dynamics of the market process may be missed if type distributed lag models using OLS, a host of researchers
one overlooks one or more of the steps of our framework have applied increasingly sophisticated time series methods
(e.g., structural breaks). to study the LPMC data.4
Palda (1964) provides a detailed review of the circum- Recently, Baghestani (1991) uses cointegration analysis
stances that led to the disclosure of advertising and sales to investigate the advertising± sales relationship for LPMC.
figures of LPMC. He also reviews the pertinent aspects of He found that the advertising expenditure and sales figures
the history of LPMC. This section first traces the relevant of LPMC are cointegrated in the order of one and, therefore,
events that throw light on the advertising strategy of LPMC estimated an error correction model (ECM) to capture the
(drawing mainly from Palda, 1964). short-run dynamics and long-run equilibrium conditions.
The primary product (nearly 99% of sales) of LPMC was Zanias (1994) replicated Baghestani's (1991) results and
a vegetable compound patented in 1873 alleged to cure a went on to show that forecasting with an ECM was more
wide variety of ills related to ``women's weakness.'' The accurate in comparison to previous models. Further, Zanias
company relied solely on advertising as a means of promo- found bi-directional Granger-causality between sales and
tion (Palda, 1964), changing the advertising copy only three advertising of LPMC.
times in the 54-year period. The aim of the advertising copy Despite their state-of-the-art application of (Baghestani,
was to stimulate primary demand (Palda, 1964). Of the three 1991; Zanias, 1994) modern time series techniques, the
advertising copy changes, two were due to orders issued by results from these bivariate cointegration analyses could be
governmental regulatory agencies. The first of the two copy misleading for the following two reasons. First, one cannot
changes came about in November 1925 when the Food and be sure that the results do not suffer from bias due to omitted
Drug Administration (FDA) issued a cease and desist order. variables, which could impact sales. In accordance with the
In 1938, the Federal Trade Commission had new objections law of demand, price is one such variable. In addition, the
to the then existing form of advertising of LPMC, which health of the economy is likely to influence demand and
resulted in the second copy change in 1940. Winer (1979) thereby sales. In order to remedy the omitted variable bias
succinctly summarized the advertising copy positioning and to investigate the impact of price and the economic
strategy for LPMC as ``universal remedy'' for the period environment on sales, we include GDP to capture the level of
1907 ±1914, ``relief for menstrual problems'' for the period economic activity and unemployment rate to utilize business
1915 ±1925, ``vegetable tonic'' for the period 1926 ±1940, cycles in addition to advertising expenditure and price.
and ``universal remedy'' again, for the period 1940 ±1960. The second potential shortcoming, concerned with the
In addition to these copy changes, LPMC followed an political ± legal environment, is that of the changes in
aggressive advertising strategy under Lydia Gove, who took
over as director of the company in 1925. This streak of
aggressive advertising (which started in 1926) reached its 3
From 1915 ± 1917, the price of the product in the liquid tonic form
peak in 1934 with advertising to sales ratio of 85%. The and the tablet form was US$7.28 and was increased to US$9 and then
then president of the company, Arthur Pinkham, took US$10 in 1918 and 1930, respectively. In May 1947, the price of the liquid
objection to the huge expenditure on advertising, resulting form of the product was increased to US$11 and then to US$12 in January
1948. The price for the tablet form of the product was increased to US$9.67
in a court case. This led to relatively lower levels of
in June 1948, to US$10.30 on March 1956 and finally to US$11 in
advertising from 1936. Schmalensee (1972) estimated that November 1956 (see Palda, 1964, p. 39).
on average advertising was set at 64% of sales for the period 4
These include Clarke and McCann (1973), Houston and Weiss
1926 ±1936, whereas it was around 46% of sales for the (1975), Caines et al. (1977), Helmer and Johansson (1977), Kyle (1978),
other years. Weiss et al. (1978), Winer (1979), Hanssens (1980a), Mahajan et al., 1980,
Erickson (1981), Bretschneider et al. (1982), Harsharanjeet et al. (1982),
The vegetable compound did not have any close sub-
Heyse and Wei (1985), Magat et al. (1986). It is not our objective to survey
stitute available for the time period (1907 ± 1960) under the entire stream of research that this database has generated. Our analysis
investigation, thereby ruling out any competitive advertising is based on two recent articles (Baghestani, 1991; Zanias, 1994), which
effects (Palda, 1964). The price of the product, available in utilize the techniques we explicate in this paper.
R. Grewal et al. / Journal of Business Research 51 (2001) 127±144 133
advertisement copy, which were required due to the regula- recommended to test for the order of integration of time
tions by federal agencies, namely FDA and FCC. Resolu- series data.7 The augmented Dickey ± Fuller (ADF) test, a
tions by such federal agencies are applied standards of what generalized form of the Dickey ±Fuller test, is useful for
the concerned agency conceives to be of public interest and testing for unit roots after incorporating appropriate lags.
these resolutions reflect issues of not only political ± legal The following ADF equation is estimated:
nature but also reflect cultural ± social values (Palamountain,
1955). We expect these mandatory advertisement copy X
ip
Dyt a0
ytÿ1 bi Dytÿi1 "t
1
changes to influence the sales of LPMC and model these i2
as constraints imposed by the legal environment. This
surfaces in the statistical analysis in the form of structural where
is the coefficient of interest. If we fail to reject H0:
breaks in the parametric model estimated. In light of this,
= 0, then the equation has a unit root, i.e., the underlying
we test for structural breaks and incorporate the detected data generating process is non-stationary. However, it is
breaks into the cointegration analysis.5 possible that the equation has more than one root. Dickey
and Pantula (1987) suggest that one could use the Dickey±
Fuller test recursively on successive differences of the
4. Statistical analysis concerned variable to detect multiple roots. While using the
Dickey± Fuller tests, one must ensure that error terms are
In this section, we use cointegration analysis to examine uncorrelated and have constant variances. Phillips and
the impact of deflated GDP (RGDP), unemployment Perron (1988) developed a similar procedure to allow for
(UEMP), and deflated price (RPRICE) on both deflated milder assumptions about the distribution of the error
advertising (RAD) and sales (RSALES). In addition, we terms. Note that the null hypothesis of non-stationarity
investigate how advertising and sales influence each other in forms the basis for both the Dickey ±Fuller test and the
the presence of these three variables. In the case of LPMC, Phillips ±Perron test.
the price of the vegetable compound remained fairly stable We utilize the Akaike Information Criterion (AIC) and
for the period under investigation, but the price in real terms Bayesian Information Criterion (BIC) as fit statistics for
was changing. It is the price in real terms that truly reflects determining appropriate lag lengths. For RSALES and
the cost of a product; therefore, we use real price as an UEMP, both AIC and BIC gave two lags as appropriate.
explanatory variable.6 As the nominal price was fairly For the other three variables, there was no agreement
stable, one could view RPRICE as instrumenting inflation- between the two criteria. As the goal is to find proper
ary pressures. To eliminate any spurious correlation due to relationships between variables, we took a conservative
inflationary effects between advertising and sales and to perspective and used the maximum of the appropriate lag
remain consistent across variables, we deflated both adver- length indicated by the two criteria.8 Hence, we use lag
tising expenditure and sales revenue. The consumer price lengths of three, four, and four for RAD, RPRICE, and
index (base year 1967) was used to deflate advertising, RGDP, respectively.
sales, and price, and the GDP deflator (base year 1967) was We present the results of the unit root tests in Table 1.
used to deflate GDP. The results show that the five variables are all integrated of
order one, i.e., they are I(1), processes and, therefore, the
4.1. Unit root tests system seems appropriate for cointegration analysis.9 How-
ever, Perron (1989) found 14 macroeconomic time series to
If a non-stationary time series yt can be made stationary be either stationary or trend-stationary after correcting for
after differencing it d times, then yt is said to be integrated of structural breaks. In line with the evidence presented by
the order d (denoted as yt I(d)). Tests suggested by Dickey Perron (1989), we went about testing for structural breaks in
and Fuller (1981) and by Phillips and Perron (1988) are our five time series.
Table 2
Unit root test with structural breaks
Variable Year of break L* t-statistic hypothesis 1 t-statistic hypothesis 2 t-statistic hypothesis 3
RAD 1925 0.35 ÿ1.79 ÿ2.64 ÿ3.17
RAD 1934 0.52 ÿ1.80 ÿ2.59 ÿ3.61
D1RAD 1925 0.35 ÿ3.61 ÿ3.61 ÿ3.90
D1RAD 1934 0.52 ÿ3.98a ÿ3.62 ÿ3.93
D2RAD 1925 0.35 ÿ5.67b ÿ5.50b ÿ5.69b
D2RAD 1934 0.52 ÿ5.53b ÿ5.50b ÿ5.45b
RSALES 1925 0.35 ÿ1.50 ÿ3.72 ÿ3.11
RSALES 1938 0.59 ÿ2.26 ÿ3.17 ÿ3.09
D1RSALES 1925 0.35 ÿ4.18c ÿ3.79 ÿ4.32a
D1RSALES 1938 0.59 ÿ3.94a ÿ3.83 ÿ3.89
D2RSALES 1925 0.35 ÿ5.03b ÿ4.92c ÿ4.98b
D2RSALES 1938 0.59 ÿ4.76b ÿ4.89b ÿ4.70c
RPRICE 1933 0.50 ÿ0.11 ÿ2.83 ÿ0.03
D1RPRICE 1933 0.50 ÿ3.34 ÿ3.30 ÿ4.39a
RGDP 1931 0.46 ÿ2.22 ÿ3.61 ÿ4.24a
RGDP 1938 0.59 ÿ2.11 ÿ3.71 ÿ3.91
D1RGDP 1931 0.46 ÿ4.48b ÿ4.58b ÿ4.46a
D1RGDP 1938 0.59 ÿ4.95b ÿ4.55c ÿ4.90b
UEMP 1930 0.44 ÿ4.23c ÿ2.89 ÿ4.59c
* L is computed as the number of years till present (i.e., test date) divided by the total number of years.
a
Significant at 1% level.
b
Significant at 2.5% level.
c
Significant at 5% level.
To summarize, after incorporating structural changes, for cointegration. Let Xt be a vector of n variables all
there were three I(1) variables, namely RAD, RSALES, integrated of order d, i.e., I(d). Estimate a vector A of size
and RPRICE and two trend-stationary variables, RGDP and n such that
UEMP. Note that the finding concerning the two macro-
A0 Xt et
5
economic variables is consistent with that of Perron (1989).
If et is integrated of order d ÿ c, where c 1, then the
4.4. Reconciling unit root tests before and after incorporat- variables in the vector Xt are said to be cointegrated of
ing structural breaks order c.
Baghestani (1991) and Zanias (1994) used the Engle and
Our unit root tests showed all variables to be I(1) Granger (1987) procedure to test for cointegration between
processes, whereas after compensating for structural breaks advertising and sales of LPMC, which are both I(1). Further,
we find the three firm level variables, viz., advertising, they found the two variables to be cointegrated. Enders
sales, and price, to be I(1) processes, but the two macro- (1995), among others, points out that the inherent weakness
economic variables, GDP and unemployment to be trend- of the Engle and Granger methodology is that it relies on a
stationary. To investigate all possible scenarios, we decided two-step estimation procedure; as a result, the inferences for
to test model with five I(1) variables and a model with three the second step depend on which error term from the first
I(1) variables. step is used in the second step. Thus, it is possible that
depending on the choice of the error term one could either
4.5. Cointegration tests find the variables to be either cointegrated or not cointe-
grated. Enders (1995) recommends using Johansen's (1988)
In general terms, if there exists a stationary linear methodology, which relies on the relationship between the
combination of two or more variables, all of which are rank of a matrix and its characteristic roots.
integrated of the same order, say d, i.e., they are all I(d), Johansen's method is a multivariate generalization of the
such that this linear combination is integrated of order I(d ÿ Dickey± Fuller unit root test. Eq. (6) depicts this general-
c), where c 1, then these variables are said to be ization.
cointegrated. Cointegrated variables share a common sto-
DXt
A1 ÿ IXtÿ1 "t
6
chastic trend (Stock and Watson, 1988).11 Engle and Gran-
ger (1987) proposed a straightforward methodology to test where Xt and "t are the (n 1) vectors of variables and
errors, respectively, DXt represents Xt in first difference, AI
is a (n n) matrix of parameters, and I is an (n n)
11
See Hamilton (1994) and Enders (1995) for a thorough exposition of identity matrix. The tests entail estimating the rank of (A1
issues relating to cointegration. ÿ I ), which equals the number of cointegrating vectors. In
R. Grewal et al. / Journal of Business Research 51 (2001) 127±144 137
Table 5
Granger causality
Model RAD RSALES RPRICE RGDP UEMP
A. Granger causality results: F-tests
Model 1: VAR with structural breaks in levels
RAD Granger caused 6.00a 10.92a 0.69 1.64 0.54
RSALES Granger caused 2.12 7.46a 0.93 4.15b 2.34
Model 2: Three-variable cointegration
RAD Granger caused 20.01a 16.50a 12.43a 1.91 1.42
RSALES Granger caused 0.41 0.76 0.05 2.72c 1.96
Model 3: Five-variable cointegration
RAD Granger Caused 18.41a 15.09a 11.21a 11.36a 13.11a
RSALES Granger caused 1.19 1.57 0.81 2.72c 2.16
Fig. 3. Impulse response functions of interest. (a) Model 2: shock to advertising response sales lag. (b) Model 2: shock sales response advertising lag. (c) Model
3: shock advertising response sales lag. (d) Model 3: shock sales response advertising lag.
of order one. In addition, we find price, GDP, and depression took some years to set in. The two breaks in
unemployment also to be integrated of order one. Further, sales were in 1925 and 1938. The break in 1925 coincided
we find two structural breaks in both advertising and sales. with the first federal reprimand, whereas the second break
The structural breaks in advertising are in 1925 and 1934. is at the end of the aggressive advertising streak by Lydia
The first structural break coincides with the first federal Gove. We do not observe any impact of the second federal
regulation against LPMC. The second break seems to be a intervention in 1940, perhaps, because the product had
result of the depression and it appears that the impact of already acquired a negative reputation. The one break in
price is in 1930 and, as expected, coincides with the weak effect of advertising on sales, as the environmental
great depression. variables explain more forecast error variance than advertis-
After incorporating structural breaks, the unit root tests ing. The IRFs show that advertising does have a short-term
suggest that the order of integration of advertising, sales, effect on sales, but the effect of sales on advertising is much
and price is the same. Even though the order of integration stronger. This leads more support to the thesis that advertis-
of advertising and sales remain the same after incorporat- ing levels were determined based on sales.
ing structural breaks, the breaks alter the data generation
process for the two series. This is evident from the time
plots of advertising and sales (Fig. 4) and is confirmed by 5. Conclusion
the Perron's (1989) test.
We identify one cointegrating vector, but this vector is Modeling of marketing interactions is important for
comprised of advertising, sales, and price and not advertis- both marketing researchers and marketing practitioners.
ing and sales as in previous research (Baghestani, 1991; With the growth in availability of single source data (cf.,
Zanias, 1994). Further, unlike the previous two research Curry, 1993) time series modeling is becoming more
endeavors, we find that advertising does not Granger cause important for both academicians and practitioners. We
sales. It seems, at least in the case of LPMC, that the LPMC borrow from the recent literature in time series on
executives determined the advertising levels by relying on multi-equation modeling to collate a set of econometric
previous year's sales. However, advertising did not signifi- tests and estimation techniques necessary for the use of
cantly influence sales. Perhaps, this insight explains the cointegration analysis. Cointegration analysis will aid in
second structural break in advertising. As the advertising the analysis of dynamic marketing interaction models and
levels were based on sales, the advertising expenditure was help in uncovering the underlying dynamic process. The
decreased when the depression had a significant influence framework provides guidelines as to the steps necessary
on sales. The variance decomposition results confirm the for the use of cointegration analysis.
where Aijk(L) is the polynomial in the lag operator L. We can write Eq. (A) as:
PE1 A AP P AE 1 E1 AE 2 E2 AE E "
where PE1 is the ( p + e1) 1 vector of pperformance variables and e1 endogenous effort variables; Pis the p 1 vector of
performance variables; E1 is the e1 1 vector of endogenous effort variables; E2 is the e2 1 vector of exogenous effort
variables; E is the e 1 vector of environmental variables; and "is the ( p + e1) 1 vector of error terms. Further, A is the ( p +
e1) 1 vector of constants; Ap is the ( p + e1) p matrix of coefficients; AE1 is the ( p + e1) e1 matrix of coefficients; AE2 is
the ( p + e1) e2 matrix of coefficients; AE is the ( p + e1) ematrix of coefficients.
R. Grewal et al. / Journal of Business Research 51 (2001) 127±144 143
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